Performance

[galumay]

Measuring the performance of our SMSF has been something that I have thought about quite a bit over the years, and changed my methodology as my thinking changed. I started off using relative benchmarks, so the return compared to the ASX 200 Franking credit adjusted, total return tax exempt, but I was always troubled by the short term nature of this sort of relative benchmark, so I moved to an absolute benchmark - aimng for more than 10% CAGR over the life of the SMSF.

When I thought about it I still wasn't comfortable with this, all these benchmarks rely on calculating a potential capital value of the portfolio at a given point in time, the big problem with that is that we don't realise the capital returns at that point, so the return calculated is meaningless.

I have decided to take a much more realistic benchmark, actual realised returns on invested capital - same way as you would calculate return on cash invested in the bank. So I took the initial capital we invested, added all the dividend returns for the past 6 years, added all the personal contributions we made, and then took the total dividends earned this year on the invested capital and expressed it as a yield - we returned 5.7% for the FY2021 (all dividends have been paid by today, 10/6.) The range has been 3.8% and 6.4% over the 6 years.

In hindsight I think an actual, realised return of over 5% is very satisfactory, more importantly I think that considering the returns in this way and ignoring the much higher potential capital gains means that in the event of a substantial drawdown in the market, I would be emotionally very comfortable and it would be very likely that the real returns measured in this way would suffer very little if any negative impact.

[galumay]

FY 2021 Performance of SMSF

I am continuing to develop the metrics to measure the performance of our SMSF and have also added an overall look at the earnings yield and P/E ration of the portfolio.

The reason for these metrics is to help to think about the portfolio as if we were a business owner, so I have calculated the EPS multiplied by the number of shares held for each business to show our share of the total earnings of each business.

The earnings yield I have calculated in two different forms, the yield on earnings in 2020 for the SMSF holdings divided by the portfolio value,  and also divided by the cost base of the holdings, again the reasoning for looking at the yield on the cost base is to think about the return on the capital invested. If we had bought 100% of a business and were measuring returns on capital, we wouldn't calculate that on what we thought a random person might offer us for the business, we would calculate it on our invested capital.

On this basis our average P/E across the portfolio is 22.8 - reflected in the relatively high p/e of the current market.

Our earnings yield on cost base is 7.85% and on EOFY share prices it is 4.4%

As reported in the previous post, our cash returns on invested capital for FY 2021 were 5.7%.

[galumay]

I want to articulate how I am considering the performance of our SMSF portfolio in a clear & concise manner, its probably best to restate my strategy for the SMSF,

We seek to invest capital as a partial owner of businesses that, if we had sufficient capital, we would seek to buy the whole business at the price indicated by the share price at the time of taking a position.

Our intention is to partially own these businesses as long as they continue to be businesses we would be happy to own in entirety.


The objective of the SMSF Portfolio is to earn a superior cash return, on the invested capital, by comparison to either bonds or cash. The superior cash return is currently targeted at 5%.

I measure that objective by dividing the total dividends, including franking credits, by the original invested capital, plus accumulated dividends and accumulated personal contributions over the life of the SMSF. That provides a cash yield on the invested capital.

I also measure the earnings yield on the cost base of total invested capital. This yield should increase every year.

[galumay]

Another consideration is the activity of the portfolio over the year, I sold 6 businesses, 3 at a loss, 3 at a profit. Most of these were legacy positions where I held no conviction and should have never bought, or sold earlier!

I only took 4 new positions.

Although its doing precisely what I said I was avoiding, considering  potential capital gains, its of some interest to note that every single business we hold now, that we held at EOFY 2020, the shares are trading at a higher price at the EOFY 2021.